Pensions have not been particularly newsworthy since the death of Robert Maxwell, but the Chancellor's budget speech on 19 March this year changed all that, as Mr Osborne announced "the most far reaching reform to the taxation of pensions since the regime was introduced in 1921". Some may dispute this claim, but there is no question that the change was both unexpected and significant, in allowing individuals to take their pension in whatever combination of income and lump sums the individual would prefer, taxed at the marginal rate.
The changes are sweeping and wide-ranging, and it is difficult at times to distinguish the press rhetoric from the facts, the enacted from the proposed, and the precise from the conceptual. However, the changes are enacted through three different acts and proposed acts of Parliament, the Finance Act 2014, the Taxation of Pensions Bill and the Pension Schemes Bill, each with its own timeline and restrictions.
The Finance Act 2014
These changes came into effect from 6 April 2014 and dealt with relaxations in the provision of existing methods of drawing a pension. This allows those taking flexible drawdown (the process by which the fund can be taken as a lump sum so long as sufficient funds are retained for an income) to retain a fund providing just £12,000 (down from £20,000). It also permits those taking income drawdown (where the income is drawn from a fund retained to provide a pension) to take up to 150% of the amount of pension that could be bought with the fund (up from 120%. Finally, there is an increase to the size of pension fund that can be paid out in full as a lump sum, because it is too small to provide a useful pension (known as "trivial commutation"). The limits have increased from £2,000 to £10,000 for the fund in one pension scheme and from £18,000 to £30,000 if all the individual's pension funds are taken into account.
The Taxation of Pensions Bill
The Treasury's proposed act of Parliament to deal with the most sweeping changes announced in the budget is due to come into force by April 2015. The details (as we have them) are set out in the first draft of the Taxation of Pensions Bill published on 14th August. The basic points are as follows:
- The new "flexi-access" drawdown is to be available from 6 April 2015, at which point funds can be allocated for full drawdown on this basis. Members who are already in drawdown can notify their administrator to change their fund to flexi-access drawdown. In addition, it is possible to take a new type of lump sum, an uncrystallised funds pension lump sum, of which the tax charge is on 75% of the whole, to retain the 25% pension commencement lump sum tax free status.
- Trust-based schemes will not be obliged to allow flexi-access drawdown of pension for members. The bill provides for a permissive power to allow flexi-access drawdown so that trustees may do so, "despite any provision of the rules of the scheme (however framed) preventing such payment". Whether the trustees will be able to do so or in those circumstances be willing to permit flexi-access drawdown is another question. Depending on the purpose of the scheme, it may be that trustees will feel constrained that they are acting outside the purpose in providing a drawdown of funds rather than a pension to a member, which is unlikely to be held to be "a provision of the rules of the scheme", and is rather a constraint of trust law.
- An anti-abuse rules is proposed to deal with the risk that members might take their salary as a pension contribution and draw it straight away, once working past the age of 55, effectively taking 25% as a tax-free salary (because of the 25% tax free lump sum). Under the rule, once flexible retirement commences, the annual allowance for contributions is limited to £10,000 in relation to money purchase contributions.
- A number of existing restrictions on the way that annuities must be structured for the purposes of the Finance Act are to be relaxed.These include the requirement that an annuity must be of a fixed or increasing rather than reducing amount, that it must have a 10 year guarantee and that a member or a dependant must have had an opportunity to choose the dependant's annuity provider. Again, with an occupational scheme it may be difficult for trustees to comfortably agree to provide an annuity that reduces over time given the risk of inflationary loss and the likely increase in expenditure in old age.
There is as yet no mention of the Chancellor's latest proposal from his Party Conference, that the provisions that give rise to punitive tax rates on drawdown after 75 or on death should be removed. The budget proposals were that this should be considered, but the conference speech was much more emphatic than that and we shall, no doubt, see provisions to deal with this in the next draft of the bill.
The Pension Schemes Bill
The Pension Schemes Bill has been introduced to provide for "defined ambition" pensions, the new type of pension halfway between defined benefit and defined contribution that has been proposed by Steve Webb, the Minister for Pensions. It is proposed that this bill will include the other changes announced in the budget, but as yet none of these have been included in the drafts or proposed amendments. These changes are also intended to be in place by April 2015, but there has been some concern voiced as to how quickly they can be implemented in practice.
The main changes are as follows:
- In order to allow members of occupational schemes the opportunity to use drawdown if the scheme does not provide it, the right of any individual to transfer to another pension scheme which is presently limited to any time up to one year prior to retirement will be extended so that a member can on reaching retirement transfer to another fund immediately in order to draw down the pension as they wish.
- Defined benefit pension scheme members will only be permitted to transfer to defined contribution schemes once they have taken independent financial advice.
- All individuals on reaching retirement age will receive financial "guidance" on the options available to them. Scheme trustees and providers will be under an obligation to ensure this is available, and the guidance will be funded by a levy on financial institutions. Initially, the guidance will be provided by two not for profit organisations, the Money Advice Service and the Pensions Advisory Service and regulated by the Financial Conduct Authority.
Because the legislation is yet to be drafted, there is a great deal of uncertainty about the details of these changes, and this has given rise speculation, in particular with relation to the last point, known as the "guidance guarantee". The operation of the guidance guarantee and the scope and extent of the guidance it provides remains uncertain at this stage.
The pensions industry is keen to react to the changes from the 2014 budget but remains somewhat hampered by the uncertainties that remain. The industry is aware of the need to move quickly to deal with the new regime but it is difficult to prepare with the ongoing uncertainty as to much of the operational change that is proposed.